1) Field of the Invention
The field of the present invention relates to an automated system and method for the assessment of an individual's attitude towards financial risk.
2) Background
Risk is involved where a choice has to be made, and there is uncertainty about the outcome of at least one of the alternatives. Risk tolerance is the level of risk with which an individual is comfortable. As such, it is a personal attribute. In relation to an individual's attitude towards financial risk, it is desirable from many points of view to make an assessment for risk tolerance.
Studies confirm that people generally do not accurately estimate their own risk tolerance (and, not surprisingly, given the difficulties in any communication about an intangible, that their advisers' estimates are less accurate than their own). While the pattern of estimates is scattered, there is a slight overall tendency to under-estimate. A possible explanation for this is that the majority of the population is, in absolute terms, more risk-avoiding than it is risk-seeking. Faced with a choice between a certain profit and an uncertain, but probably larger profit, a sizeable majority chooses the certain (but probably smaller) profit. Someone, who in absolute terms is slightly risk-averse, may not realise that this is typical of the population as a whole.
For a measure of risk tolerance to be useful, the underlying methodology must ensure validity, reliability and accuracy. Validity requires that the methodology actually measures what it purports to measure. Reliability means that methodology is consistent for the same individual with time.
A system and method for assessing personal risk tolerance satisfying these criteria is useful to the individual so far as it will assist them in gaining self-knowledge to assist in making appropriate decisions concerning their financial position. There are also advantages for financial advisors, in that they will be able to advise clients in making financial decisions in a manner more in sympathy with their clients' attitude towards risk. For example, where an advisor would normally commend a course of action which involves a level of risk greater than the client's tolerance, both client and advisor should be aware of the conflicts so that they can work towards a compromise. Similarly, where a course of action involves a level of risk lower than the client's risk tolerance, the client and the advisor can decide on higher goals, or on diverting some resources elsewhere, or perhaps, simply to accept greater certainty of the lower risk.
The Financial Services industry is so pervasive and of such a size that it touches every adult American at one stage or another through their lifetime so far as decisions in investment, insurances, borrowing, purchasing, and so on are concerned.
A known risk tolerance instrument is described in the “Survey of Financial Risk Tolerance” (SOFRT), developed by The American College, of 270 S. Bryn Mawr Avenue, Bryn Mawr, Pa. 19010, and released in 1994. The College is a private US University established by the Insurance industry in the 1970s. The author of the survey is Michael J. Roszkowski PhD. The SOFRT was designed as an instrument for financial advisers to use with their clients. It is available as a PC-based software package. Alternatively, advisers can have clients complete a hard copy questionnaire and then forward it to the College for processing.
The above-referenced risk tolerance instrument operates by providing an individual with a questionnaire comprising 57 multiple-choice questions, where each choice is numbered (e.g. 1-5). Each answer is scored by using the number chosen. The sequence of choices is either from low risk to high risk, or high risk to low risk. In the latter case, the choice numbers are reversed during scoring.
Two overall scores are then calculated: a Risk Tolerance Score and a Consistency Score. The Risk Tolerance Score is, in effect, the sum of scores for individual questions, scaled linearly in the range 0 to 100. The risk tolerance scores have a mean of 43 and a standard deviation of 11. The Consistency Score is a “manufactured” variable used to measure the “scatter” of the person's individual answers around their Risk Tolerance Score.
A printed report is produced in which the Risk Tolerance Score is stated, along with the percentage of higher/lower. scores. The Consistency Score is used to report consistency in terms of the proportion of people who have higher or lower scores. The printed report also indicates whether the respondent has an accurate self-impression of risk tolerance. To make such a determination, the first question in the questionnaire asks respondents to rate themselves compared to others on a scale of 1 (extremely low risk taker) to 7 (extremely high risk taker). The accuracy of this self-impression is reported by way of comparing the person's risk tolerance score with the average of the scores for those who made the same choice in the first question. However, the unsophisticated nature of the report in general means that the SOFRT has limited value to individuals and their advisers. Additionally, there are generally considered to be too many questions, and the questions are of a nature that is not easily understood by respondents.